KEY CHANGES FROM 18 MARCH 2015
- Share disposals are no longer subject to the “look through” rule that previously applied to a corporate shareholding of 10% or more in a joint venture company (the “JVCo rule”).
- A new rule treats the activities of a company as the member of a partnership as not being trading activities, regardless of what the company or the partnership does.
- The changes in the rules are stated to be aimed at arrangements which allowed the JVCo rule to be used in order for indirect shareholdings of less than 5% in a trading company to qualify for Entrepreneurs’ Relief (“ER”) contrary to the policy intention. It is widely understood that the use of intermediary companies for management teams to invest in Management Buy-Outs and Management Buy-Ins are the ‘arrangements’ at which the changes in legislation are directed.
- However, the changes also catch arrangements which were not designed to circumvent the 5% qualifying shareholding rule and could mean that existing, wholly benign investment structures no longer qualify for ER.
ER – the old rules
Under the old rules to determine whether a company with a shareholding of 10% or more in a Joint Venture Company (“JVCo”) qualified for ER, the shareholding was ignored and the investing company was treated as carrying on a relevant proportion of the activities of the JVCo directly. Somewhat surprisingly, the purpose of the investment and, in particular, whether the JVCo’s activities had any relationship with the investing company’s activities was of no consequence to a claim for ER.
For a company which carried on a trade in partnership with others, its status for ER purposes prior to 18 March 2015 was determined under general tax principles which treat a partnership’s trading activities as carried on directly by its members, in proportion to each member’s partnership share.
ER – the new rules
Although there is nothing in the draft legislation which was published for consultation on 10 December 2014 about these changes to ER, the Finance (No.2) Bill 2015 published on 24 March this year includes the insertion of a new sub-section (4A) into s169S TCGA 1992 (“Entrepreneurs’ Relief – interpretation”) the effect of which is to abolish the look-through rules for investments in JVCos and interests held in partnerships, in determining a company’s qualifying status for ER.
The abolition of the look through rule in relation to investment in a JVCo would have been sufficient to close the loophole that existed pre-FA 2015 and address the mischief at which the FA 2015 changes were directed. It is not at all clear, therefore, why any change in the treatment of partnership interests was needed and this point is not addressed in the Explanatory Notes which were published together with the Finance Bill on 24 March.
In view of the upcoming general election the Finance Bill was hurriedly enacted with only 1 day of parliamentary scrutiny, in contrast to the extended period over which a Public Bill Committee normally considers specific clauses in the bill. Perhaps this explains why the new legislation catches far more than might have been necessary.
Uncertainty over the partnership rule
There remains a fundamental uncertainty over how the new partnership rule will work in practice. In relation to a corporate member of a partnership, the new sub-clause tells us how we are not to treat a partnership’s activities for the purpose of a claim to ER. What it does not tell us, in specific terms, is how we should treat a partnership’s activities for this purpose.
Are the partnership’s activities to be treated in every case as “investment activities” irrespective of the nature of the partnership’s actual activities? At face value, that is what the new rule seems to say. However, an alternative interpretation might be to simply “disregard” the partnership’s activities altogether. If that were the case, a claim to ER would depend solely upon the activities of the investing company.
It might be that such uncertainty will need to be resolved with HMRC on a case by case basis, perhaps through the Non-Statutory Business Clearance process but, in our view, that would be an unsatisfactory resolution to such a fundamental issue. Unfortunately, because of the lack of any consultation and only limited parliamentary scrutiny that may, for now, be the only viable option in individual cases where a disposal is anticipated.
An explanation of the parliamentary draftsman’s intention, in deeming the activities of a partnership not to be trading activities would be a welcome but also, now, an unlikely development.
If anything discussed in this Newsletter is, potentially, of relevance or interest to you or any of your clients, please contact a member of the Trident Tax team.